Estate planning practitioners regularly include some form of withdrawal rights in irrevocable trusts, exercisable with respect to a specific amount and for a limited period of time, to enable the trust's donor to use his Internal Revenue Code Section 2503(b) annual exclusion from gift tax for contributions to the trust. A withdrawal right must be included to provide the beneficiary with a “present interest” in the gift. By providing the withdrawal rights, all practitioners want to ensure that the maximum amount of each contribution isn't subject to gift tax. But the methods practitioners use to both create and administer withdrawal rights vary widely.

To determine whether practitioners use one set of procedures most often in administering trusts subject to withdrawal rights, we posted an inquiry on the American College of Trust and Estate Counsel (ACTEC) listserv asking participants to briefly describe how they ordinarily direct trustees to give notice to beneficiaries of their withdrawal rights. From the initial responses, it was apparent that the notice procedures varied greatly among practitioners. Michael D. Whitty of Chicago's Vedder Price then turned the inquiry into a web survey. Seventy-six ACTEC members responded to the survey. The results showed that: (1) 62 percent of the responding members have trustees send written notice of withdrawal rights to each beneficiary and request that the beneficiary acknowledge receipt of the notice in writing, but don't request an affirmative waiver of the withdrawal right by the beneficiary, (2) 30 percent have trustees send written notice to each beneficiary, but don't request acknowledgement or waiver by the beneficiary, (3) 5 percent have trustees send written notice to each beneficiary and request both acknowledgment and waiver from the beneficiary, and (4) 3 percent send a one-time written notice to each beneficiary with a prospective, permanent but revocable, waiver of his withdrawal rights. Some respondents also provided the rationale behind their selection, for example, that they request acknowledgment of notice from a beneficiary as a way to provide a record of notice for the file or alternatively that they specifically don't request acknowledgment of notice because it may “raise eyebrows” at the Internal Revenue Service if a signed acknowledgment is never returned. Several respondents noted that they don't request an affirmative waiver of a withdrawal right because it would be treated as a release, leading to unintended gift tax consequences.

In light of the varied responses received from this survey, we decided to review the statutes, case law and rulings governing the use of withdrawal rights to determine whether there's one, definitive best practice to recommend to practitioners when administering withdrawal rights. We recommend that practitioners take the steps described below when advising clients and trustees on how to provide trust beneficiaries with actual notice of their withdrawal rights. We've based our recommendations on a careful review of the published authority on the subject, consideration of the ACTEC survey results and common practice indicated by that survey. We focus on the methods that are most likely to actually be followed and, therefore, result in the best evidence being available on audit to prove that the notice was properly provided.1

Withdrawal Rights Basics

Providing a beneficiary of an irrevocable trust with withdrawal rights over contributions to the trust ensures that the property subject to those withdrawal rights can be classified as a gift of a present interest, thereby allowing it to qualify for the annual exclusion from gift taxes under IRC Section 2503(b). That section provides that the first $10,000 (adjusted for inflation to $13,000 for calendar year 2011) of gifts of a present interest in property by a donor to a donee is excluded from the donor's total taxable gifts made during the calendar year. This amount is generally referred to as the “annual exclusion amount.”

When we refer to a trust which provides a withdrawal right, we're referring to a trust agreement that provides that, whenever property is contributed to the trust, one or more trust beneficiaries (or a guardian or other person on behalf of a minor or otherwise incapacitated beneficiary) has a right to withdraw a portion of such contribution for a certain period of time. The trust agreement usually provides that the trustee must give the beneficiary timely notice of each contribution and notify the beneficiary of the amount subject to his withdrawal right. That amount is capped at the annual exclusion amount, reduced by any previous gifts to that beneficiary by the donor within the same calendar year. If the beneficiary doesn't notify the trustee of his election to exercise the withdrawal right, the right to withdraw usually lapses after a period of time or at the end of the calendar year. To avoid the lapse of a withdrawal right being treated as a release of a general power of appointment and, therefore, a taxable gift to the beneficiary under IRC Section 2514(e), many trust agreements also provide that the right to withdraw any amount in excess of the greater of (1) $5,000, or (2) 5 percent of the of the value of the assets out of which the exercise could be satisfied (the “5-or-5” exclusion), won't lapse and will instead “hang” until such hanging amount can lapse in a subsequent year without causing a release. Alternatively, a beneficiary could be given a limited testamentary power of appointment to avoid adverse tax consequences of an immediate lapse in excess of the 5-or-5 exclusion.

Trust beneficiaries rarely exercise their withdrawal rights, as both donors and beneficiaries usually prefer that trust contributions remain in the trust to be invested for future growth or to finance insurance premiums on one or more life insurance policies held by the trust. While both parties' long-term goals are achieved by allowing contributions to remain in the trust, donors and beneficiaries must never have an express or implied agreement that the withdrawal rights will never be exercised. The IRS views any advance agreement between donors and beneficiaries not to exercise withdrawal rights as though the withdrawal rights were illusory and will deny treatment of such gifts as gifts of present interests that qualify for the annual exclusion.2

Future vs. Present Interests

The caveat in IRC Section 2503(b) is that gifts of “future interests in property” are ineligible for annual exclusion treatment.3 The term “future interest” is defined in Treasury Regulations Section 25.2503-3 as a gifted interest in property, which is limited to commence in use, possession or enjoyment at some future date or time. The regulation further explains that a donee has a “present interest” in gifted property if he has an unrestricted right to the immediate use, possession or enjoyment of such property or the income from such property. Absent the right to withdraw the assets contributed to an irrevocable trust, the gift is generally treated as a gift of a “future interest.” The withdrawal right converts that “future interest” to a “present interest” and makes the annual gift tax exclusion available to the donor.

Crummey v. Commissioner

The landmark case dealing with IRC Section 2503(b) gifts of present interests is the 1968 U.S. Court of Appeals for the Ninth Circuit's decision in Crummey v. Commissioner.4 The court in Crummey held that a gift to an irrevocable trust would be treated as a “present interest” in such property, thereby qualifying for the annual exclusion, if the trust provided a beneficiary (or a beneficiary's guardian on his behalf, in the case of a minor) with an unrestricted right to immediately withdraw the property.

To have a present interest under Crummey, a trust beneficiary must be legally and technically capable of immediately possessing or enjoying the gifted property and have a reasonable opportunity to do so. The ability to legally exercise a withdrawal power turns on the provisions of the trust providing the beneficiary with such a right and, in the case of a minor beneficiary, state law regarding a guardian's right to exercise a withdrawal right on the minor's behalf. As long as there's no legal impediment to the ability of a beneficiary to exercise his withdrawal rights during the period the right to withdraw is “open,” this element doesn't pose a problem to the present interest requirement.5 The concern for practitioners in drafting trust agreements and for trustees in administering them is providing beneficiaries with a reasonable opportunity to exercise the withdrawal rights.

Reasonable Opportunity

For a beneficiary to have a reasonable opportunity to exercise a withdrawal right, the beneficiary must be (1) aware that the right exists, and (2) given enough time to exercise the right before it lapses.6 All of the circumstances surrounding the making of the gift, the timing of notice and the length of the exercise period are taken into account in assessing whether a beneficiary has a reasonable opportunity to exercise his withdrawal right.

The second requirement noted above can be easily met. Many private letter rulings have held that it's sufficient to give a beneficiary or guardian at least 30 days after receiving notice to exercise his withdrawal right prior to any lapse.7 Although the beneficiary's or guardian's right to withdraw contributed property should always commence on the date of contribution,8 the exercise term needn't start and finish within a single calendar year for the annual exclusion gift to be deemed made in the calendar year in which it was made.9 In one PLR, any demand to withdraw contributed property had to be made 30 days after the property was contributed, not 30 days from when notice was given, but because “prompt” notice of all additions to the trust was required, the IRS approved the timing provisions of the trust and allowed gifts made to that trust to qualify for the annual exclusion.10 In PLRs in which a beneficiary had only a few days to exercise the withdrawal right, however, the IRS has found the rights to be illusory, resulting in the gifts being treated as future interests.11 Therefore, we recommend that the withdrawal period specified in the trust agreement start on the date on which the property was contributed to the trust and continue until at least 30 days after the date of notice before it lapses. Some trust agreements provide that lapse of the withdrawal right occurs on Dec. 31 of each year regardless of when the contribution is made, because a donor may make multiple contributions during the year. In these cases, the agreement should also specify that any gifts made after Dec. 1 shall lapse instead on a date in the following calendar year (for example, on Feb. 1 or Dec. 31 of the following calendar year) to avoid a curtailed withdrawal period of fewer than 30 days.12

The first requirement noted above — ensuring that the beneficiary is “aware” of his withdrawal right — is of greater concern. This requirement is the reason why the notice of the withdrawal right (the “Crummey notice”) must be provided to a beneficiary and the authority is clear: So long as the beneficiary receives actual notice, the first requirement is satisfied. However, as the ACTEC survey shows, the method of providing notice to beneficiaries varies greatly among trustees. Moreover, practitioners are unlikely (and frequently unwilling) to monitor the annual notice procedure for all of the years in which withdrawable contributions are made to a trust. It is, however, the practitioner's responsibility to properly instruct donors and their trustees on how to administer the trusts to ensure gifts are treated as present interests. While the administrative burden of annually notifying beneficiaries is onerous and easily overlooked by trustees, establishing a reliable system at the inception of a trust is imperative to ensure the donor's gift tax objective is attained.

Trust Agreement Guidance

To ensure that donors receive annual exclusion treatment for gifts to trusts, it's imperative that guidance be provided in the trust agreement itself regarding the steps that the trustee must take whenever a withdrawable contribution is made.

Require provision of reasonable notice — The trust agreement should require the trustee to provide each beneficiary or his guardian (or, as discussed below, perhaps another designated individual on behalf of a minor), with notice of withdrawal rights within a reasonable time after any gift subject to a withdrawal right is made to the trust. The trust agreement needn't specify the precise manner, timing and contents of this notice (discussed in greater detail below). That's because if the trustee provides notice to the beneficiaries in a manner that differs from what the agreement requires, the trustee will violate the terms of the agreement and potentially be liable to the beneficiaries, even if the trustee has met the legal requirements regarding notice. For maximum flexibility, the trust agreement should include a nonexclusive list of several manners by which the trust may provide notice, such as written, verbal or electronic notice (which, in today's environment, could include email, text or even Facebook notice), to support a trustee's assertion upon audit that notice was provided via a method sanctioned by the trust agreement. Requiring that the trustee provide notice, within a reasonable time, to those holding withdrawal rights is sufficient to oblige the trustee to properly inform beneficiaries, without imposing unnecessarily strict requirements that a trustee may fail to follow precisely. (See “Sample Notice and Designation of Agent,” this page.)

Designate an individual to receive notice on behalf of minor beneficiary — If a beneficiary holding a withdrawal right is a minor, the trust agreement should inform the trustee of the appropriate individual to whom notice should be given on the minor's behalf. The trust can provide that a minor's natural or legal guardian is an appropriate recipient of notice on the minor's behalf. However, given that a minor's parents may later die or divorce, leading to uncertainty as to whom should receive notice, the trust agreement could also contain a provision empowering the trustee to designate a particular individual — which could include not only one of the minor's parents or the child's known legal guardian (if not a parent), but also any responsible adult in the child's life, including the trustee — to receive notice on the minor's behalf.13 If the trustee designates himself as the minor's agent, which is effectively the case when the non-settlor parent of a minor is the trustee, the trustee will always have “actual notice” of the contribution when it's received from the donor and therefore may not need to provide notice to himself on behalf of the minor.14 In any event, if the individual who made the contribution to the trust is one of the minor's parents, to avoid any problems with IRC Section 2036, notice shouldn't be given to the donor-parent but instead to the other parent on behalf of the minor.15 (See “Sample Designation of Agent,” p. 24.)

Release trustee from liability — Because many trustees frequently fail to provide timely notice to beneficiaries and their guardians, the trust settlor may want to consider providing that the trustee isn't liable for failure (other than failure as a result of bad faith) to provide notice to beneficiaries or their guardians as required by the agreement. Without a release from liability in the trust agreement, it may be difficult for a settlor to find someone willing to act as trustee if there's a concern that the trustee may be sued for failing to adhere to the notice requirements.

Manner of Notice

All that's required is that the beneficiary receives actual notice of his right to withdraw. However, proving to the IRS that the beneficiary received such notice is another matter altogether. Here are our views on the different kinds of notice that the trustee could give, and how, from an evidentiary perspective, the donor can prove the delivery of the notice on audit.

Written notice

From an evidentiary perspective, the optimal way for a trustee to notify a beneficiary or guardian that the beneficiary has a withdrawal right with respect to a gift or a contribution is for the trustee to give the beneficiary or guardian written notice. In the event of an IRS audit, a copy of the notice signed by the trustee, along with a statement affirming that the notice was mailed to the beneficiary or guardian, is strong evidence that the beneficiary was made aware of his withdrawal rights. As further evidence that notice was provided to the beneficiary or guardian, some practitioners send notices via certified mail with return receipt requested, although no ruling has specifically addressed the benefit of this additional burden and expense.

Of course, having this proof only leads to an evidentiary finding that the trustee provided the notice. To prove actual notice as required by applicable authority, the beneficiary must also be shown to have received the notice. Those practitioners who recommend that the trustee give written notice might also advise the trustee to send an acknowledgment form to the beneficiary or guardian for signature stating that he has received the notice of withdrawal right from the trustee and request that the beneficiary mail back the acknowledgment. As there's no requirement that written notice itself be given, there is, naturally, no requirement that the beneficiary or guardian give written acknowledgment of receipt of the notice. However, a copy of the written notice mailed along with a copy of a signed acknowledgment that the beneficiary received the written notice provides hard evidence that the beneficiary actually received the notice.

The potential problem with requesting a signed acknowledgement is that beneficiaries and guardians often fail to return the signed acknowledgement to the trustee. If the signature line for the acknowledgment is on the same page as the trustee's signature on the notice, there could be a concern that an unsigned acknowledgment may unfairly give the impression to an auditor that the notice was in fact not received by the beneficiary. Therefore, if a practitioner chooses to recommend that trustees get written acknowledgments of notice, it's advisable to provide a separate acknowledgment instrument to the beneficiary for signature, as opposed to adding the beneficiary's signature line to the notice letter itself. In either case, copies of all documents provided to the beneficiary will be produced at audit, but the absence of a returned, signed acknowledgment form may be less likely to give the auditor the impression that notice wasn't received than a missing beneficiary's signature on the notice itself. (See “Sample Beneficiary Acknowledgment,” p. 25.)

Verbal notice

It's important to note that, while written notice is recommended, IRC Section 2503(b), the Treasury regulations, revenue rulings and case law are devoid of any requirement that a beneficiary receive written notice. In fact, the Tax Court has held that beneficiaries who were verbally informed of their withdrawal rights were adequately informed, despite a trust agreement requirement that the trustee provide written notice.16 Providing written, as opposed to verbal notice is recommended so that the donor has proof, in the event of audit, that notice was in fact given to the beneficiary. However, verbal notice meets the requirement that a beneficiary or guardian be made aware that the withdrawal right exists and the requirements for timely exercise.

To simplify the notice process and relieve some of the burden on the trustees, practitioners should consider having each beneficiary or guardian sign an initial consent to receive verbal notice of withdrawal rights from the trustee with respect to gifts in subsequent years. Agreeing in writing to receive verbal notice would provide some evidence that the beneficiaries were properly notified in subsequent years and given a reasonable opportunity to exercise their withdrawal rights, while also explaining why no written evidence of subsequent notifications exists. Following this approach allows the trustee to show that the trust specifically granted him the right to give notice verbally, and the beneficiary specifically acknowledged that verbal notice was acceptable to him. This shows “both sides” of an actual verbal notice regime and provides the best chance that the auditor will find that the beneficiaries actually received the notice.

If verbal notice is used, the auditor will invariably ask the beneficiaries to confirm that verbal notice was actually received. In our experience, beneficiaries are unlikely to deny having received verbal notice — especially if they're made aware of the fact that not remembering the receipt of notice will result in the imposition of more taxes and a reduction in what the beneficiaries might receive as gifts or inheritance. It's important to recognize that it's the practitioner's duty to advise the beneficiaries not to commit fraud in responding to this question if raised by the IRS.

Actual notice

If the trustee is himself a beneficiary holding a withdrawal right, or the trustee is the parent and natural guardian of a minor beneficiary holding a withdrawal right, the IRS has noted that the trustee has “actual notice” of the withdrawal rights by virtue of his status as trustee. As a result, the trustee needn't provide any formal notice to himself with respect to either his own withdrawal rights, or the withdrawal rights of his minor children, because actual notice suffices.17

Continuing notice

If a trust holds an insurance policy, such as a term or group-term policy, for which premiums are due in specific amounts according to an established schedule, two PLRs, albeit issued many years ago, have held that a trust agreement made adequate provision for notice by requiring the trustee to provide a single notice to each beneficiary setting out: (1) the amounts and premium due dates, (2) the amounts and dates of future trust contributions, and (3) the terms of the withdrawal rights.18 Given that a beneficiary should be as well informed of his withdrawal rights if provided with notice of the rights in advance, as opposed to annually each year when they arise, the IRS concurred that the single initial notice could serve as “continuing notice” with respect to future contributions made in accordance with the schedule. Therefore, in the case of an insurance trust holding a policy for which the timing and amount of future contributions are known with certainty, a single continuing notice provided to the beneficiaries upon the inception of the trust can help the trustee establish that notice was properly given in the event the trustee fails to follow up with annual notices in subsequent years. If the amount or timing of insurance payments changes in any subsequent year, however, the trustee must provide current notice to the beneficiaries to inform them of these changes, as the continuing notice would no longer suffice under those circumstances.

Electronic notice

The fastest and least burdensome form of written communication today is email. The time and date recorded on an email can be printed as evidence that notice was timely sent by a trustee to a trust beneficiary or guardian.19 In addition, replying to an email to acknowledge its receipt takes far less time and effort on behalf of a beneficiary or guardian than mailing a written receipt of notice back to the trustee. Emails, if properly stored electronically, are far easier to retain and subsequently locate than paper files.

Practitioners could therefore encourage trustees to email notice to a beneficiary or guardian by providing the trustees with a basic form email, including all of the information that would be included in the written form of notice described above, and include a request that the beneficiary or guardian simply reply to the email to confirm receipt. If a trustee and the beneficiary or guardian use email regularly or if it seems unlikely that a particular trustee will be diligent enough to follow through with mailing timely notice every time a contribution is made to a trust, encouraging the practice of email notice as an alternative to traditional mail would provide the same form of written evidence that notice was given and received, despite being documented in a less formal manner. Since it's possible that a trustee may fail to send written notices altogether, emailing notice could, at a minimum, be proposed as a backup practice.

Remember, actual notice is required. Therefore, a trustee who sends a text message notifying a beneficiary of a right of withdrawal has actually notified the beneficiary. If the beneficiary sends a text back acknowledging receipt, that return text can be good evidence of actual notice received. However, text messages aren't typically printed or saved. As a result, using them as evidence that actual notice occurred can be difficult — short of obtaining copies from the service provider. That's why text notice is a possible, but not recommended, alternative for giving notice.

The use of new technology in this context is a fascinating subject with unique characteristics that allow the notice procedure to be both efficient and instantaneous. For example, the trustee could even choose to create his own trust website and give beneficiaries a password to access notices and other trust information, or create a restricted Facebook group for beneficiaries and give notice of withdrawal rights to group members by both personal messages and as updates to the group page. It may take less time and effort on behalf of technologically savvy trustees and beneficiaries to notify beneficiaries in this manner and to receive acknowledgements if the medium so permits, rather than send sending written notices and acknowledgements back and forth by traditional mail. From an evidentiary point of view, the trustee can provide to an IRS agent the records of a Facebook group's activity and messaging as proof that actual notice was given and received. The downside to a trust website would be the inability to track a beneficiary's access to particular information posted on the website and the improbability that a beneficiary would regularly check a limited-purpose website as frequently as his existing Facebook account. While a trustee could likewise use Twitter to notify beneficiary “followers” of their withdrawal rights via direct messaging, the 140-character limit on Twitter direct messaging may render this option less desirable. A disadvantage of using a service such as Facebook or Twitter to provide notice is that both sites are more commonly used to broadcast information publicly, and a trustee unfamiliar with privacy settings may unwittingly share confidential trust information with someone other than the intended recipient. Taking all of these considerations into account, we believe email is the optimal manner of providing electronic notice to beneficiaries because it's the most simple and ubiquitous form of electronic communication. Most importantly, email messages are private communication between the sender and the recipient and can be easily saved and printed for later use as evidence.

Contents of Notice

When a trustee provides notice to a beneficiary or guardian, the notice should include: (1) a statement that a gift that was made to the trust, (2) the amount of the gift that's subject to the particular beneficiary's right of withdrawal, (3) the amount of time the beneficiary has to exercise the withdrawal right before it lapses, and (4) a request that the beneficiary notify the trustee if he wishes to exercise the withdrawal right. Including these four items will ensure that the beneficiary is fully aware of the nature of his withdrawal right and informed of the manner in which it must be exercised. The initial notice could also include a copy of the relevant portions of the trust instrument providing the withdrawal right. If notice is being provided to the guardian of a minor beneficiary (or to someone designated to receive notice on behalf of the beneficiary if the trust agreement so provides), it should contain all of the same information noted above with additional language stating that notice is being provided to the guardian on behalf of a particular beneficiary. (For suggested language to use in an initial notice, see “Sample Initial Notice,” p. 27.) After an initial notice explaining the nature of withdrawal rights and attaching the relevant trust provisions is provided to a beneficiary or guardian, any subsequent notice need only include the date of the contribution, the amount subject to withdrawal as a result of the contribution and the time frame within which the beneficiary must notify the trustee of his intent to exercise. If hanging powers are used in the trust agreement, the subsequent notice should also remind the beneficiary that withdrawal rights with respect to previously contributed property may still exist. (For suggested language to use in a subsequent notice, see “Sample Subsequent Notice,” p. 28.)

Advance Waiver of Notice

While it would simplify a trustee's notice obligation if he could elicit advance waivers of notice of all future gifts from the beneficiaries, practitioners should hesitate before encouraging this practice. Although the determination is nonbinding, the IRS issued a Technical Advice Memorandum in 1995 that rejected the use of advance waiver of notice and denied annual exclusions for gifts made after beneficiaries executed the waivers.20

This TAM has been extensively criticized for its holding and rationale, given that a waiver of notice doesn't in any way restrict or defeat a beneficiary's legal right of withdrawal. Nevertheless, the IRS argued that failing to inform the beneficiary of withdrawable additions effectively prevented the beneficiary from having the ability to possess or enjoy the property. Although the TAM's holding may not stand up in formal litigation on the issue of waiver, it's still prudent to discourage a trustee from obtaining advance waivers of notice of future gifts from beneficiaries. Otherwise, that trustee may end up the defendant in a test case.

Waiver of Withdrawal Right

As noted in the results of the ACTEC survey, a few respondents encourage trustees to get written waivers of exercise of withdrawal rights from the beneficiaries. The problem with this is that a withdrawal right is a general power of appointment under IRC Section 2514(c) and a waiver of the right isn't a “lapse” under IRC Section 2514(e) for which the 5-or-5 exclusion is available. As a result, the beneficiary will need to treat as a gift the entire amount of the contribution for which he waived withdrawal rights, as opposed to just the amount in excess of the 5-or-5 exclusion. Therefore, trustees shouldn't ask beneficiaries to make an affirmative waiver of their withdrawal rights when providing them with notice if the donor intends to take advantage of the 5-or-5 exclusion — the rights should simply be allowed to lapse, subject to a hanging power for the amount in excess of the 5-or-5 exclusion.

Practitioner Procedure

Most practitioners would probably prefer not to be involved with the annual responsibility of tracking clients' contributions to trusts, preparing timely withdrawal rights notices for trustees and following up on notice mailings and acknowledgments of receipt. In fact, most clients would prefer not to have to pay their attorneys to take on this responsibility. Therefore, each time a trust with a withdrawal right is created, the practitioner should take the time to review the notice procedure with the trustee and provide the trustee with an initial package of forms, both in hard copy and in electronic form for ease of editing and a set of detailed administration instructions that the trustee can refer to each year when a contribution is made. Making sure the trustee fully understands his notice responsibilities and providing the trustee with forms will help ease the administrative burden on both the trustee and the practitioner going forward. For the practitioner's protection, he should inform the client in writing that the notice procedure isn't the practitioner's responsibility and, unless contacted by the client to provide assistance, the practitioner is excused from involvement in the process going forward.

Audit Example

To demonstrate how following our recommendations can assist a trust donor in the event of an audit, consider the case of a standard insurance trust holding a single life insurance policy on the life of a parent settlor. The policy requires that a fixed premium be paid once a year. The only contribution to the trust is a gift of the premium due each year. That contribution is made one month before the premium's due date. The trust agreement imposes a notice requirement on the trustee.

At the time the trust is created, the trustee provides the adult beneficiary with a form of continuing notice stating the date each year when the gift will be made to cover the insurance premium and the amount of the premium and informing the beneficiary of the withdrawal right and manner of exercise. The trustee also has the beneficiary consent in writing to receive verbal notice in subsequent years. The practitioner provides the trustee with forms with which to provide the beneficiary with annual notice, but the trustee fails to send the annual notice.

If the donor is audited with respect to gifts made to the insurance trust, the trustee can state that he provided the beneficiary with verbal notice of the gifts as permitted in the agreement and the trustee can provide the IRS with the beneficiary's signed consent to receive verbal notice. The beneficiary can also sign an affidavit stating that he received verbal notice (again, after being advised to be truthful in preparing the affidavit). If the auditor is still unwilling to accept the fact that verbal notice was given, the trustee can also show the auditor a copy of the continuing notice provided in accordance with the holding in PLRs approving the practice with respect to insurance premiums due on a consistent schedule. Having multiple avenues by which a trustee can support his assertion that notice was adequately provided should ensure that the audit results in a favorable decision for the donor.

A Simpler Approach

Adherence to the rules regarding notice of withdrawal rights is an annual burden to trustees of many irrevocable trusts. Perhaps out of an abundance of caution, many of the procedures developed by practitioners to assist donors in obtaining their annual exclusions for gifts to the trusts go above and beyond what's legally required to constitute reasonable notice under IRC Section 2503(b). While some trustees and beneficiaries do regularly adhere to the procedures, many don't, due to the time and effort required to draft and mail annual notices and to follow up with beneficiaries on receipts. Those trustees put clients at risk of losing annual exclusion treatment on trust contributions if they're audited. In these cases, practitioners may want to consider recommending some of the simpler, alternative methods of notice, such as consent to verbal notice or email notice and receipt, to make it more likely that trustees will follow through with their obligations, while still complying with the requirements of IRC Section 2503(b) and providing evidence of such compliance in the event of audit.

The authors would like to thank Jay D. Waxenberg, David Pratt and Howard M. Zaritsky for their valuable comments to this article.

Endnotes

  1. The subject of withdrawal rights is extremely broad and encompasses many concepts, including but not limited to hanging powers, tax consequences of the lapse of withdrawal rights, income tax consequences associated with withdrawal rights and generation-skipping transfer tax considerations related to trusts that allow for beneficiary withdrawals. This article is limited in scope and intended only to address how to give notice of withdrawal rights — or, as they have come to be known — “Crummey notices.”
  2. See AOD 1996-010, 1996-29 Internal Revenue Bulletin, July 15, 1996, in which the Internal Revenue Service stated that it will continue to deny annual exclusion treatment if circumstances indicate a prearranged understanding that withdrawal rights won't be exercised or that an exercise would result in adverse consequences to the holder (that is, cause the holder to lose the right to withdraw any subsequent contributions).
  3. Congress created this distinction between present interests and future interests because it intended for the Internal Revenue Code Section 2503(b) exclusion to be “available only in so far as the donees are ascertainable, the denial of the exemption in the case of gifts of future interests is dictated by the apprehended difficulty, in many instances, of determining the number of eventual donees and the values of their respective gifts.” See H. Rept. No. 708, 72nd Congress, 1st Session, p. 29; S. Rept. No. 665, 72nd Cong., 1st Sess., p. 41.
  4. Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968).
  5. See Revenue Ruling 73-405, 1973-2 C.B. 321, in which the IRS accepted that a gift in trust to a minor, without formal appointment of a legal guardian, was a gift of a present interest so long as there was no legal or other impediment to the appointment of a guardian with the right to exercise the withdrawal right on the minor's behalf.
  6. See Rev. Rul. 81-7, 1981-1 C.B. 474.
  7. See Private Letter Rulings 200130030 (April 30, 2001), 200123034 (March 8, 2001), 200011054 (Dec. 15, 1999), 199912016 (March 26, 1999) and 9311021 (Dec. 18, 1992). In Estate of Christofani v. Comm'r, 97 T.C. 74 (July 29, 1991), the Tax Court held that a trust providing each beneficiary with a withdrawal right exercisable for only 15 days following the date of contribution was sufficient to provide the beneficiaries with present interests in the contributions. Nevertheless, we still recommend that the withdrawal period last until 30 days after the date of notice, as the 30 day period has consistently been approved in later PLRs.
  8. The withdrawal right should commence upon the date of contribution, not the date upon which notice is provided, to ensure that the interest in the contributed property is a present interest.
  9. See Rev. Rul. 83-108, 1983-2, C.B. 167.
  10. See PLR 8922062 (March 7, 1989).
  11. See supra note 6. In the situation in which a gift was made to a trust on Dec. 29 and the beneficiary had until Dec. 31 of that year to exercise a withdrawal right, the IRS stated that the narrow restriction on the exercise window was, in part, responsible for denial of annual exclusion treatment for the gift. See also PLR 7946007 (July 26, 1979), in which the beneficiary only had three days to exercise his withdrawal right, and the IRS stated that the donor didn't give the trustee a sufficient length of time after establishing the trust on Dec. 29 to inform the beneficiary of his withdrawal right before lapse on Dec. 31 of the same year.
  12. Even if the withdrawal right lapses in a subsequent year, the gift is still treated as having been made in the year of its contribution. See, e.g., supra note 9.
  13. In Rev. Rul. 73-405, supra note 5, the IRS confirmed that no legal guardian of a minor trust beneficiary need be formally appointed for gifts to the minor to qualify as present interests. In addition, some states have specific statutes concerning the nomination of a representative to receive notice on behalf of a minor. For example, under Florida law, if specifically nominated in the trust instrument, one or more persons may be designated to receive any notice, information, accounting or report on behalf of a beneficiary. See Florida Statutes Section 736.0306.
  14. See PLR 8008040 (Nov. 28, 1979), in which a trustee who was also an adult trust beneficiary didn't need to send notice to himself. By the same logic, if the trustee is the person designated to receive notice for a minor beneficiary, no notice would need to be sent by the trustee to himself. We note, however, that there's no case or ruling directly on point as it applies to notice for a minor beneficiary being satisfied as aforesaid.
  15. See Treasury Regulations Section 20.2036-1(a).
  16. See Estate of Carolyn W. Holland v. Comm'r, T.C. Memo. 1997-302. The Tax Court heard “convincing testimony” that beneficiaries were given “actual notice” and held that the trustee's failure to provide written notice as required under the agreement “does not require a finding that the beneficiaries did not have present interests in the gifts.”
  17. See PLR 8008040, supra note 14.
  18. See PLRs 8121069 (Feb. 26, 1981) and 8133070 (May 21, 1981).
  19. Forty-seven states (all except Illinois, New York and Washington), the District of Columbia, Puerto Rico and the U.S. Virgin Islands have enacted the Uniform Electronic Transactions Act, which provides that a “record … may not be denied legal effect or enforceability solely because it is in electronic form.” Illinois has enacted the Electronic Commerce Security Act, which provides that “[i]nformation, records, and signatures shall not be denied legal effect, validity, or enforceability solely on the grounds that they are in electronic form.” (5 ILCS 175/5-110). New York has enacted the Electronic Signatures and Records Act, which provides that “[a]n electronic record shall have the same force and effect as those records not produced by electronic means.” (N.Y. STT Law Section 305(3)). The Washington Electronic Authentication Act provides guidelines for the recognition of electronic signatures. (RCW Chapter 19.34.)
  20. See Technical Advice Memorandum 9532001.

Andrew M. Katzenstein is a partner in the personal planning department of Proskauer Rose LLP and is based in the firm's Los Angeles office. Lindsay R. Sellers is an associate in the same office

Sample Notice and Designation of Agent

What to include in a trust to satisfy Crummey requirements

The rights of withdrawal granted under Article [Number] of this Agreement may only be exercised by a written instrument delivered to the Trustee. The Trustee shall make reasonable efforts to notify each beneficiary, or his or her agent, of the beneficiary's right of withdrawal with respect to each addition within a reasonable time after the addition is made. Such notification efforts may include: (i) apprising each beneficiary or agent of the beneficiary's right to withdraw by written notice, verbally, or by electronic mail, (ii) providing the beneficiary or agent with a single, continuing notice sufficient to apprise him or her of current and expected future rights to withdraw or (iii) any other means determined by the Trustee to provide each beneficiary or agent with reasonable notice of the withdrawal rights. Notwithstanding any other provision of this Agreement, the Trustee shall not be liable to the maximum extent permitted by law for failure to give notice under this Paragraph, unless the Trustee's failure is a result of the Trustee's bad faith.

If a beneficiary is not legally competent and has no agent, the Trustee may designate a person or persons (including a natural or legal guardian of the beneficiary who is not the donor) as agent to receive notice on behalf of the beneficiary with the authority to exercise the beneficiary's withdrawal right on his or her behalf. Such designation shall be revocable and amendable by the Trustee. If the Trustee does not otherwise designate an agent to receive notice on behalf of a person not legally competent to receive it, the Trustee shall instead notify the beneficiary's natural or legal guardian on behalf of the beneficiary.
Andrew M. Katzenstein & Lindsay R. Sellers

Sample Designation of Agent

Specify another person to exercise a withdrawal right on behalf of someone not legally competent to do so

Paragraph [Number] of the [Name of Trust Agreement] dated [Date] (the “Trust”) provides that the undersigned, as Trustee of the Trust, has the right to designate an agent to exercise the withdrawal rights set forth in Article [Number] thereof on behalf of a minor. The undersigned hereby exercises this power by appointing the following person to act as agent for the following minors:

Minor:

Agent:

Dated:

_____

Trustee

Andrew M. Katzenstein & Lindsay R. Sellers

Sample Beneficiary Acknowledgment

Prove receipt of written or email notice and agreement to receive verbal notice

I hereby acknowledge [(on behalf of [minor beneficiary])] that I have received notification from [name of trustee] informing me of my rights of withdrawal [(on behalf of [minor beneficiary])] over a contribution that was made to the [name of trust] and that I am willing to receive verbal, rather than written, notice of future contributions to said trust.

_____

[Signature of beneficiary or guardian]

Andrew M. Katzenstein & Lindsay R. Sellers

Sample Initial Notice

Introduce the trustee and describe the trust's withdrawal provisions

[Name of trust agreement]

[Name of trustee(s)]

[Date]

[Name and address of beneficiary or guardian]

Dear [name]:

I am the trustee of the above-referenced trust created by [donor]. Under the terms of the trust agreement, in each calendar year, you [(on behalf of [minor beneficiary])] have certain powers of withdrawal. I am required to give you [(on behalf of [minor beneficiary])] notice of those rights of withdrawal with respect to the initial contribution and each addition to the principal of the trust within a reasonable time after the contribution or addition is made. The trust provisions relating to those withdrawal powers are excerpted and included as an attachment to this notice.

A contribution in the amount of $[amount] was made to the trust on [date]. Therefore, you [(on behalf of [minor beneficiary])] now have the right to withdraw $[amount] of this contribution.

In order to exercise your right of withdrawal, you must notify me in writing, in my capacity as a trustee, and let me know the amount that you want to withdraw. If you do not notify me of your intent to exercise this right [within X number of days from the date of this notice][before the end of the year], the withdrawable amounts will diminish [within X number of days from the date of this notice][at the end of the year] in accordance with the terms of the trust agreement.

[Please acknowledge that you have received this notification by [signing the enclosed acknowledgment and returning it to me][replying to this email acknowledging your receipt thereof].]

____

Trustee

(Note that this form can be used for email or other electronic communications as well.)

Andrew M. Katzenstein & Lindsay R. Sellers

Sample Subsequent Notice

Explain what the beneficiary must do to exercise his withdrawal rights

[Name of trust agreement]

[Name of trustee(s)]

[Date]

[Name and address of beneficiary or guardian]

Dear [name]:

As trustee of the above-referenced trust, I hereby notify you [(on behalf of [minor beneficiary])] that on [date], a contribution in the amount of $[amount] was made to the trust. You now have the right to withdraw up to $[amount] [(on behalf of [minor beneficiary])].

In order to exercise your right of withdrawal, you must notify me in writing, in my capacity as a trustee, and let me know the amount that you want to withdraw. If you do not notify me of your intent to exercise this right [within X number of days from the date of this notice][before the end of the year], the withdrawable amounts will diminish [within X number of days from the date of this notice][at the end of the year] in accordance with the terms of the trust agreement.

As I previously have advised you, you [(on behalf of [minor beneficiary])] may also have rights of withdrawal with respect to prior contributions to the trust. If you should ever want to exercise those rights, I will provide you with the total amount withdrawable at that time. In order to exercise any right of withdrawal, I must be given written notice in my capacity as trustee.

[Please acknowledge that you have received this notification by [signing the enclosed acknowledgment and returning it to me][replying to this email acknowledging your receipt thereof].]

_____

Trustee

Andrew M. Katzenstein & Lindsay R. Sellers